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Saturday, December 27, 2014

Behind the Fall of Russia's Ruble: Inflation, Oil Prices, Sanctions, and More

Russia’s economy is in trouble. Growth has come to a halt. A recession looms in 2015. Inflation, interest rates,

and capital flight are up. The government’s budget is under strain. More than any of these, what makes the headlines is the plunge of the ruble, which, at one point in mid-December, had lost half of its value against the dollar in less than a year. What lies behind the weakness of the ruble? Is it harmful in itself, or is it better understood as a symptom of other problems? What options are open to Russian policymakers as they struggle to manage their currency’s descent?

Accounting for inflation

As in many discussions of macroeconomics, we first need to deal with the effects of inflation. Economists use the term nominal to refer to quantities stated in the ordinary way and real to quantities that are adjusted to for inflation. Real wages are the most familiar example: We all understand that if our boss raises our nominal wage from $10 per hour to $12 per hour, but at the same time inflation adds 20 percent to the price of everything we buy, our true purchasing power has not changed.

A similar principle applies to exchange rates. Other things being equal, a change in the nominal exchange rate of the ruble would mean change in the competitiveness of goods the country produces for export and those it produces for sale at home in competition with imports. However, inflation also has an impact on competitiveness—one that can either amplify or offset changes in the nominal exchange rate. >>>Read more

Follow this link to view or download a slideshow tutorial with more information on real and nominal exchange rates

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